Capital One 2015 Annual Report Download - page 193

CAPITAL ONE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
174 Capital One Financial Corporation (COF)
NOTE 11—DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
Use of Derivatives
We manage our asset and liability positions and market risk exposure and limits in accordance with our market risk management
policies that are approved by our Board of Directors. Our primary market risks stem from the impact on our earnings and economic
value of equity from changes in interest rates and, to a lesser extent, changes in foreign exchange rates. We employ several techniques
to manage our interest rate sensitivity which include changing the duration and re-pricing characteristics of various assets and
liabilities by using interest rate derivatives. Our current policies also include the use of derivatives to hedge foreign-currency
denominated exposures so we may limit our earnings and capital ratio exposure to foreign exchange risk. We execute our derivative
contracts in both the over-the-counter (“OTC”) and exchange-traded derivative markets, and clear derivative transactions through
a central clearinghouse as required by the Dodd-Frank Act. The majority of our derivatives are interest rate swaps. In addition, we
may use a variety of other derivative instruments, including caps, floors, options, futures and forward contracts, to manage our
interest rate and foreign exchange risks. We offer various interest rate, foreign exchange rate and commodity derivatives as an
accommodation to our customers as part of our Commercial Banking business but usually offset our exposure through derivative
transactions with other counterparties.
Accounting for Derivatives
Our derivatives are designated as either qualifying accounting hedges or free-standing derivatives. Free-standing derivatives
primarily consist of customer-accommodation derivatives and economic hedges that do not qualify for hedge accounting. Qualifying
accounting hedges are designated as fair value hedges, cash flow hedges or net investment hedges.
• Fair Value Hedges: We designate derivatives as fair value hedges when they are used to manage our exposure to changes
in the fair value of certain financial assets and liabilities, which fluctuate in value as a result of movements in interest rates.
Changes in the fair value of derivatives designated as fair value hedges are recorded in earnings together with offsetting
changes in the fair value of the hedged item and any resulting ineffectiveness. Our fair value hedges consist of interest rate
swaps that are intended to modify our exposure to interest rate risk on various fixed-rate assets and liabilities.
• Cash Flow Hedges: We designate derivatives as cash flow hedges when they are used to manage our exposure to variability
in cash flows related to forecasted transactions. Changes in the fair value of derivatives designated as cash flow hedges are
recorded as a component of AOCI, to the extent that the hedge relationships are effective, and amounts are reclassified from
AOCI to earnings as the forecasted transactions impact earnings. To the extent that any ineffectiveness exists in the hedge
relationships, the amounts are recorded in current period earnings. Our cash flow hedges use interest rate swaps that are
intended to hedge the variability in interest payments on some of our variable-rate assets. These hedges have the effect of
converting some of our variable-rate assets to a fixed rate. We also have entered into forward foreign currency derivative
contracts to hedge our exposure to variability in cash flows related to foreign-currency denominated intercompany
borrowings.
• Net Investment Hedges: We use net investment hedges to manage the foreign currency exposure related to our net investments
in foreign operations that have functional currencies other than the U.S. dollar. Changes in the fair value of net investment
hedges are recorded in the translation adjustment component of AOCI, offsetting the translation gain or loss from those
foreign operations. We execute net investment hedges using foreign exchange forward contracts to hedge the translation
exposure of the net investment in our foreign operations.
• Free-Standing Derivatives: We use free-standing derivatives to hedge the risk of changes in the fair value of residential
MSRs, mortgage loan origination and purchase commitments and other interests held. We also categorize our customer
accommodation derivatives and the related offsetting contracts as free-standing derivatives. Changes in the fair value of
free-standing derivatives are recorded in earnings as a component of other non-interest income.
Balance Sheet Presentation
As of January 1, 2015, we changed our accounting principle to move from a gross basis of presentation to a net basis for presenting
qualifying derivative assets and liabilities, as well as the related fair value amounts recognized for the right to reclaim cash collateral